Saturday, March 11, 2006

Time to Buy Shares?

It's difficult to follow the story at General Motors and not feel the pain -- the pain of an American icon devastated by both external and internal forces, and fighting for its very life.

The stock price is down some 80% from its all-time high, and even adjusting for its large dividend, an investment in the company would have lost more than 65% of its value in a few short years. Declining market share, a large debt load, the recent dividend cut, and continuing heavy losses have many predicting bankruptcy.

Contrarian play?
As you might expect, such talk has got many contrarian investors in a tizzy. After all, the thinking goes, it's best to buy when the situation is darkest, because that's when the true bargains emerge.

But I'm here today to tell you not to fall for it. There is a big difference between a bargain price tag on a solid company and a speculative play on a distressed business. This is the latter.

Believe me, I'm not saying that if you buy GM right now you won't be very happy in five or 10 years. You may be. Management and the unions might finally straighten out all their problems, the revamped car line might take hold, and things might actually turn around. Bankruptcy is not imminent (CEO Rick Wagoner says it's not even under consideration now), so there is still time to nudge this ship in the right direction.

But the risk-reward ratio here should preclude consideration from all but the most speculative of investors. Labor and benefit costs are draining -- Wagoner told The New York Times that GM's health care and pension expenses run about $5 billion more than Toyota's. Toyota, Nissan, and the rest of the Japanese automakers are miles ahead in efficiency.

There's also a big problem with the "vision thing." GM, DaimlerChrysler, and Ford were taken to the woodshed by Toyota and Honda when it came to understanding Americans' desire for hybrid technology. They're now significantly behind in what has become the future of the auto industry.

There's much more than this, but in short, GM's problems run deep.

What, then?
Let's contrast the GM situation with a more Foolish style of contrarian investing. In early 2004, David Gardner found a lot to like about BMW in the midst of a beaten-down industry, and he recommended the German automaker to Motley Fool Stock Advisor members. After a few months, the stock had dropped some 10%, but David remained confident in the business.

There were several differences between BMW then and more speculative plays -- such as GM -- now. They included outstanding margins, earnings, and balance-sheet numbers compared to BMW's peers. In fact, BMW's net profit margin of 4.7% dwarfed GM's 1.2% and Ford's 0.8%. Businesses earn their profit margins over time by keeping costs down while inducing customers to pay up, and BMW's profitability puts it near the top of its industry.

Because nothing had happened to change the basics of the business since David picked it, he has recommended holding. The stock has risen nearly 13% off its lows; during the same period, GM lost 50%.

David and brother Tom have employed a contrarian patience on the way to 61% average total gains in Stock Advisor, compared to 21% for the S&P 500. You can see their two newest stock picks, as well as all their past recommendations, with a no-obligation 30-day free trial.

Patience pays
If you're looking for turnaround plays, be sure to check for the same competitive advantages David found with BMW, and remember this lesson from Tom: "When you have done the research and found a well-run business with a strong balance sheet in the midst of a turnaround, be patient, dear Fool, be patient."

2 comments:

paulwk said...

I have little doubt GM is a turnaround story waiting to happen. But how long do you really want to wait, especially with so many other good companies to invest in out there?

Chern Jie said...

Paul:That's quite an interesting blog you have. I'd like to add it to my bloglines. Thanks for the comment.